Of Course You Can Safely Lend Money To Poor People With Bad Credit

Is it always dangerous to offer a mortgage to someone with a low income and bad credit? Of course not.

Like, for example, you could sift down to people whose credit blemishes are clearly the result of an isolated incident (e.g. medical) or a specific period of financial distress.

Then of those you can find the ones with low, but very predictable incomes -- maybe they own a gas station somewhere without competition from anyone else. Maybe they're the lead janitor at a school -- or maybe they're even a teacher. And if it's obvious that they can cover the nut, then voila, it's probably okay to lend to them. So if you had an army of good bankers, and you specifically made an effort to find these people and get them buying homes, you'd probably be alright.

That seems to be how the organization Self-Help operates. They're the North Carolina lender which was profiled in that bizarre NYT op-ed about expanding the joys of homeownership to more low-income individuals. They combine assiduous underwriting skills with, easy-to-understand plain vanilla mortgages with a dollop of local knowledge. And voila, despite their demographic, their performance isn't that bad.

The author of the Times piece argued that the Self-Help model merely needs to be scaled bigger, and we'd have a real, positive low-income homeownership scheme.

It sounds fine, but there are some problems with this idea. For one thing, Self-Help may not end up being the symbol of financial health it currently seems to be. Because North Carolina hasn't been foreclosure central, it hasn't been hit too hard yet -- but they're still working on their 2008 annual report, and from a conversation we had with them, there's no doubt this is going to be a much more difficult year. We're eager to see what the report looks like.

It's also not clear that the Self-Help model is really sustainable. We had it explained to us. Basically, Self-Help got a grant from the Ford Foundation, money which allowed them to buy low-income, non-conforming loans from banks, put their seal-of-approval on it, and then flush the loan to Fannie and Freddie. So to make these loans "work" they needed both the non-profit backing and the backing of Fannie and Freddie.

But beyond that, we think the whole message here is one of anti-scale. Sure, you can find genuinely good credit risks even in a bad economic demographic, but the moment you try to scale that you run into trouble. You're likely to find sloppines, pressure to lend to more people, etc. What can work on a small scale doesn't necessarily work as a matter of national policy. And in fact that seems to be a lesson from this past crisis -- that the CRA loans (Self-Help helps banks meet their CRA quota) which seemed to work out fine, and in many areas haven't been particularly weak, didn't scale and worn't replicable as a scalable business proposition.

So our verdict remains the same: let's ease off this more homeownership kick for awhile, shall we?